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This is the second of a three-part series discussing the Utah Revised Limited Liability Company Act passed by the Utah Legislature on February 23, 2001. Part I, which appeared in the
June/July 2001 issue, gave an overview of the Revised Act and described part of the changes made by the Revised Act. Part II discusses other changes made by the Revised Act. Part III will
appear in the October issue and will discuss transition issues and tips for drafting and planning under the Revised Act.
I. Introduction
This article continues a description of the changes in Utah's prior Limited Liability Company Act (the "Old Act") made by the Utah Revised Limited
Liability Company Act- 2001 (the "Revised Act"). This description was begun in an article featured in the previous issue of the Utah Bar Journal and should be read in conjunction with that article. The Revised Act became effective on July 1, 2001.
II. Continuation of the Discussion of Changes Made by the Revised Act
Becoming an Initial Member.
The Old Act gives no guidance as to when a person becomes a member upon formation of an LLC. The Revised Act provides that, when forming an LLC, a person becomes a member at the earliest of signing the articles of organization, signing the operating agreement, or when the person's admission is reflected in the LLC's records or membership is otherwise acknowledged by the LLC. After LLC formation, the Revised Act retains the default rule of unanimous consent of all members for admission of a new member, but adds the default rule requiring the proposed member to sign the operating agreement or another writing that binds the person to the provisions of the operating agreement.
Meetings of Members.
The Old Act contains no provisions regarding meetings of members- whether they are required or not. The Revised Act clarifies that, as a default rule, no meetings of members are required. This "no meeting" rule applies in the absence of a contrary provision in the LLC's governing documents.1 In the event that the LLC's governing documents require meetings of members but fail to spell out how meetings are called, or the place, notice or quorum required for meetings, the Revised Act supplies default rules for such issues. The Revised Act also provides default rules for member actions taken without a meeting.
Voting.
The Revised Act continues the rule of the Old Act for member voting according to percentage interests in profits. Yet, the Revised Act clearly allows the LLC's governing documents to specify voting on a per capita or other basis or by a specified class or group of members.
Classes of Members.
The Old Act makes no provision for classes of members. In contrast, the Revised Act specifically allows the LLC's governing documents to provide for classes or groups of members and to allow for non-voting interests of a particular class or group.
Cessation of Membership.
The Revised Act clarifies when a person ceases to be an LLC member. Specifically, the interest of a member shifts to that of an "assignee" upon the death, incapacity or voluntary withdrawal of the member, upon assignment of the member's entire interest in the LLC, upon expulsion of the member or upon the member's voluntary bankruptcy (or 120 days after an involuntary bankruptcy petition is filed). The cessation of membership rules also extend to members who are entities. Those rules apply when articles of dissolution are filed (for a member that is an LLC or a corporation) or upon the dissolution and commencement of winding up (for a member that is a limited partnership).
Withdrawal of a Member.
The Revised Act clarifies that a member may withdraw from an LLC if withdrawal is allowed under the LLC's governing documents. Where the governing documents do not allow for member withdrawal or do not clearly specify the time or events for withdrawal, a member may not withdraw prior to dissolution and completion of winding up of the LLC- except with the consent of all other members.
Expulsion of a Member.
The Old Act makes no provision for expulsion of an LLC member. The Revised Act allows a member to be expelled pursuant to provisions of the operating agreement or (a) by unanimous vote of the other members if it is unlawful to carry on the LLC's business with the member, or (b) by court decree that the member has engaged in wrongful conduct adversely affecting the LLC's business or has willfully and persistently breached the LLC's governing documents or has engaged in conduct relating to the LLC's business which makes it "not reasonably practicable" to carry on the business with the member.
Agency Authority of Members and Managers.
The Revised Act clarifies the authority of members in a member-managed LLC and managers in a manager-managed LLC to bind the LLC in transactions with third parties. The Old Act vests management authority in the members in proportion to the members' interests in the profits of the LLC. Yet, under Old Act ¤48-2b-125(2)(a), it is unclear whether any member could bind the LLC or whether a member could bind the LLC only where other members holding a majority of the profits interests in the LLC had approved that action. The Revised Act clarifies rules on apparent authority. Section 48-2c-802 of the Revised Act sets forth two parallel sets of rules- one set for member-managed LLCs and one set for manager-managed LLCs.
In a member-managed LLC:
(a) Each member is an agent of the LLC for the purpose of the LLC's business;2
(b) An act of any member for apparently carrying on the
LLC's business in the ordinary course binds the LLC, unless the member had no authority to act for the LLC in the particular matter and such lack of authority was expressly described in
the articles of organization or the person with whom the member was dealing knew or otherwise had notice that the member lacked authority; and
(c) An act of a member which is not
apparently for carrying on the LLC's business in the ordinary course binds the LLC only if the act was authorized by the other members.
The authority rules for a manager-managed LLC are parallel to the rules for a member-managed LLC except that, in a manager-managed LLC, a member is not an agent of the LLC solely by
reason of being a member.
The Revised Act allows limits to be imposed on the apparent authority of those managing an LLC if express language is included in the Articles of Organization.
Conveyance of LLC Property.
Notwithstanding the Old Act's vesting of management authority in the members in proportion to their interests in profits, the Old Act seems to grant unconditional authority to anyone managing an LLC, without member approval, to bind the LLC in any transaction involving the acquisition, mortgage or disposition of LLC property. The Revised Act follows the same basic rule, but with two significant exceptions: (a) the articles of organization may expressly limit the authority, and (b) the person dealing with the LLC must have no knowledge or other notice of the lack of authority of the person who signs on behalf of the LLC.
Management by Members. The Revised Act sets a 3-tier structure of default rules for member approval in a member-managed LLC:
(a) Members holding a majority of profits interests must approve any matter connected with the LLC's business;
(b) All members must consent to amendments to the LLC's governing
documents and must authorize acts in contravention of the LLC's governing documents; and
(c) Members holding two-thirds of the profits interests must approve substantial events
such as making current distributions to members, converting the LLC to another entity or merging the LLC with another entity, or selling, leasing or mortgaging all or substantially
all of the LLC's property outside the regular course of the LLC's business.
In a manager-managed LLC, member approvals are also required for transactions referred to in (b) and (c) above.
Management by Managers.
The Revised Act fills gaps left by the Old Act regarding identification and qualification of managers in a manager-managed LLC. It continues the Old Act's requirement that the initial managers be designated in the articles of organization. Yet, the Revised Act requires that any changes in managers must be made by an amendment to the articles of organization. As a default rule, each manager is elected by members holding a majority of profits interests and continues to serve until the manager's death, withdrawal or removal- and may be removed with or without cause by members holding a majority of profits interests. Managers need not be members of the LLC.
Delegation of Authority.
The Old Act is silent as to the power of managers or members to delegate authority to manage. The Revised Act fills this gap with a default rule that management authority in an LLC may not be delegated. It also provides that if delegation is allowed under the LLC's governing documents, any delegation must be in writing, the scope and duration of authority delegated must be specified in writing, and the power to revoke the delegation must be retained.
Reliance on Reports and Information.
The Revised Act protects a member or manager who relies in good faith on the LLC's records or on information, opinions or reports presented to the LLC by others, unless the member or manager has knowledge concerning the matter in question that makes such reliance unwarranted.
Fiduciary Duties.
The Old Act contains no provisions regarding the fiduciary duties of persons who manage an LLC. The Revised Act clarifies these duties by prohibiting "self-dealing" transactions. Under these rules, unless otherwise provided in the LLC operating agreement, each member of a member-managed LLC and each manager of a manager-managed LLC must account to the LLC and hold as trustee for the LLC any "profit or benefit" derived by that person from using or appropriating LLC property without the consent of members holding a majority interest in profits of the LLC.
The Revised Act also sets gross negligence/willful misconduct as the standard of care for those participating in LLC management. Yet, a member in a manager-managed LLC (who is not also a
manager) owes no fiduciary duties to the LLC or to the other members solely by reason of acting in the capacity of a member. Subject to the above rules, the Revised Act allows members and
managers to transact business with the LLC the same as a third party, unless otherwise limited by the LLC's governing documents.
Actions by Multiple Managers.
The Revised Act adds a default rule regarding voting by multiple managers which requires unanimous written consent of all managers and prohibits managers from voting by proxy.
Removal of Managers by Judicial Proceeding.
The Old Act contains no provision regarding removal of managers (or members having management authority). The Revised Act allows the LLC itself, or members holding at least 25% interest in profits of the LLC, to petition the court for removal of a manager, but the court must find that the manager engaged in fraudulent or dishonest conduct or gross abuse of authority with respect to the LLC and that removal is in the LLC's best interests. A similar court proceeding can be used for removal of a member in a member-managed company.
Assessments.
The Old Act makes no provision for assessment of members for additional contributions to the LLC. The Revised Act sets a default rule that no additional contribution or assessment may be required of any member and further provides that, if an assessment obligation is provided for, such obligation does not confer any rights upon any creditor or other person not a party to the LLC's operating agreement.
Adjustments to Capital Accounts.
Part I of this series described how the Revised Act installs "capital accounts" as the new measuring standard for LLC profits and losses, distributions and voting. The Revised Act also provides for revaluation adjustments to capital accounts whenever there are capital contributions to an LLC or disproportionate distributions from an LLC (and when the LLC is dissolved and wound up). On such events, the capital accounts are adjusted to reflect the net fair market value of the LLC's assets at that time.
Valuation of an LLC Interest.
The Revised Act adopts the "willing buyer, willing seller" concept as the default standard for determining the fair market value of a member's interest in an LLC, but requires that any valuation procedure take ".
. . into consideration all relevant facts and circumstances, including the provisions of the articles of organization and operating agreement and all relevant discounts or premiums." Being a default rule, these provisions can be overridden by provisions in the operating agreement.
Redemption of Interest.
The Old Act allows a member to demand the return of the member's "contribution" upon dissolution of the LLC or when allowed under the articles of organization or when the member's interest in the LLC is terminated. The Revised Act adopts the concept of "redemption of interest" in place of "return of contribution" and entitles a member to demand payment from the LLC of the fair market value of the member's interest in the LLC only upon dissolution and completion of winding up of the LLC or when otherwise provided in the LLC's governing documents.
Allocation of Profits and Losses. The Old Act allocates profits and losses on the basis of the "value of the contributions" made by each member. The Revised Act changes
the default standard to allocate profits and losses in proportion to the members' capital account balances as of the beginning of the LLC's current fiscal year.
Allocation of Current Distributions. The Old Act allocates LLC distributions to members on the basis of the "value of the contributions made by each member to the extent
they have been received by the limited liability company and have not been returned." The Revised Act replaces the concept of "value of the contributions" with capital account balances and also clarifies the distinction between current distributions and liquidating distributions. As a default rule, current distributions are allocated among the members in proportion to the members' capital account balances as of the beginning of the LLC's current fiscal year.
Timing of Distributions.
The Old Act is silent as to the timing of current distributions. The Revised Act requires current distributions to be made to all members concurrently or at other times determined by the members in a member-managed LLC or by the managers in a manager-managed LLC.
Limitations on Distributions.
The Old Act prohibits distributions to members if the "fair value" of the LLC's assets is less than the LLC's liabilities. The Revised Act continues this standard but adds that, for distributions to be allowed, the LLC must be able to pay its debts as they become due in the regular and ordinary course of its business. The Revised Act specifies that the effect of a distribution is measured as of the date the distribution is authorized if payment of the distribution occurs within 30 days thereafter. Otherwise, the effect of a distribution is measured as of the date payment is made.
Duty to Return Wrongful Distributions.
The Old Act imposes a constructive trust on a member who receives wrongful distributions "on account of the member's contribution." The Revised Act broadens and clarifies these rules to provide that a member who receives a distribution by mistake or in violation of law or the LLC's governing documents is obligated to return the wrongful distribution and, in addition, remains liable to the LLC for up to 5 years- if a proceeding to recover the distribution from the member is commenced within the 5-year period. This member obligation applies whether or not the member knew the distribution was wrongful.
Distributions in Kind.
As a default rule, the Revised Act protects a member from being forced to receive distribution of an asset in kind from the LLC that was not contributed by the member or that is disproportionate to the member's percentage interest in the LLC. The implication remains that an LLC may force a member to take a distribution in kind, rather than in cash, of an asset previously contributed by the member or to take a percentage interest in an asset equal to the member's percentage interest in the LLC.
Charging Order- Exclusive Remedy.
The Old Act allows a judgment creditor of an LLC member to obtain a charging order against the judgment debtor's LLC interest and, thereby, to obtain the rights of a "transferee" of the member's LLC interest. The Revised Act clarifies that any such judgment creditor (or receiver appointed by the court) has only the rights of an assignee as to such interest and that any purchaser at a foreclosure sale of the LLC interest acquires only the rights of an assignee. The Revised Act also makes a charging order the exclusive remedy of a judgment creditor who seeks to satisfy the judgment out of the judgment debtor's interest in an LLC.
Assignee Becoming a Member.
The Old Act contains two conflicting provisions regarding the consent required for an assignee to become an LLC member. Section 48-2b-122(2) of the Old Act requires unanimous consent of the members for a person to become an additional member, if the operating agreement does not provide otherwise. In contrast, where a member has transferred an LLC interest to another person, Section 48-2b-131(2)(b) of the Old Act requires consent of only the "members entitled to receive a majority of the non-transferred profits" for a person to become a member. The Revised Act requires consent of all LLC members for an assignee to become a member in the LLC unless otherwise provided in the governing documents. The Revised Act makes clear that an assignee who has become a member becomes subject to the LLC's governing documents and the Act and becomes liable for obligations of the assignor to make contributions and to return distributions as provided in the Act, except for liabilities of the assignor unknown to the assignee at the time the assignee became a member. It also provides that the assignor of an LLC interest is not released from liability to the LLC by reason of the assignee's becoming a member.
Consent of All Members for Voluntary Dissolution.
The Old Act allows members holding a majority of profits interests to approve a voluntary dissolution of an LLC. The Revised Act alters this rule and requires consent of all members for voluntary dissolution.
Articles of Dissolution. The Old Act requires articles of dissolution to be filed after the winding up of the LLC is completed. The Revised Act changes this timing and requires articles of dissolution to be filed after an event of dissolution but before winding up- consistent with Utah corporate law.
Breaking Management Deadlock.
The Old Act contains no provision for breaking a deadlock in LLC management. For example, if a disagreement arose in a member-managed LLC with two equal members (50/50), the Old Act gives no guidance as to what to do. Also, there is no provision allowing resort to the courts to break the deadlock. The Revised Act allows a member to bring an action for judicial dissolution of an LLC whenever there is a deadlock among the managers which cannot be broken by vote of the members or where the members themselves are in a deadlock that continues for at least 6 months.
Dissolution by Judgment Creditor.
The Revised Act allows a judgment creditor to file an action to dissolve an LLC if: (a) the judgment is unsatisfied and the LLC is insolvent, or (b) the LLC is insolvent and has admitted that the creditor's claim is due and owing.
Purchase of Interest of Member Petitioning for Dissolution.
The Revised Act borrows from Utah corporate law to allow the LLC (or the other members) to purchase the LLC interest of a member who petitions for judicial dissolution of the LLC.
Winding Up.
The Revised Act expands provisions of the Old Act regarding winding up an LLC's business and activities. In doing so, some provisions were borrowed from Utah corporate law regarding disposition of claims against the LLC.
Distribution of Assets to Members on Winding Up.
The Old Act allocates distributions during winding up on the basis of the members' "claims for capital." The Revised Act changes this to allocate winding up distributions among the LLC members based on final capital account balances after allocation of all profits and losses accrued or incurred during winding up.
Conversions and Mergers.
The Old Act contains no provisions for conversions of an LLC and allows an LLC to merge only with another LLC. The Revised Act allows other entities to convert to LLC form and allows LLCs to convert to other forms. Conversion is accomplished by filing "articles of conversion" along with articles of organization, in the case where another entity converts to LLC form. The Revised Act also includes amendments to the Utah Revised Uniform Limited Partnership Act to give procedures for converting a Utah limited partnership to LLC form. The Revised Act also provides that a Utah LLC may merge with any other entity if the merger is permitted by the statutes governing each entity.
Professional LLCs.
Provisions relating to professional LLCs are scattered throughout the Old Act and are not consistent with provisions relating to professional corporations under the Utah Professional Corporation Act. The Revised Act collects all provisions relating to professional LLCs into one part- Part 15. In addition, the Revised Act borrows several provisions from the Utah Professional Corporation Act to make the Revised Act parallel to and consistent with the Utah Professional Corporation Act.
Foreign LLCs. The Revised Act substantially expands the provisions of the Old Act regarding foreign LLCs, making such provisions parallel to and consistent with provisions for
foreign corporations under Utah corporate law.
Stay of Derivative Proceedings.
The Revised Act allows a court to stay a derivative action temporarily if the LLC promptly commences an investigation of the allegations in the plaintiff's complaint.
This concludes the summary of changes made to the Old Act by the Revised Act. This summary is just that- a summary- and does not describe every change made to the Old Act.
Part III of this series, coming in the October 2001 issue, will discuss transition issues under the Revised Act and provide tips for drafting LLC governing documents and planning under the
Revised Act.
Footnotes
1. The term "governing documents" means an LLC's articles of organization and operating agreement.
2.
Defining the "business" of the LLC now becomes extremely important because if the purpose is broadly stated as "any lawful business," then each member in a member-managed LLC could be an agent of the LLC to the broadest extent.
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